Litigation: Directors and officers must read their indemnification and advancement rights carefully

Under Delaware law, indemnification is mandatory if a director or officer successfully defends a claim against himself. But, who pays for the defense until the case is finally decided? Such expenses could easily bankrupt all but the very wealthy. Under Delaware law, advancement of such expenses is discretionary and is determined by the precise language of a company’s charter, bylaws or separate agreement. The following case illustrates why you should read those provisions carefully.

On Dec. 31, 2012, in Miller v. Palladium Industries, Inc., the Delaware Court of Chancery granted judgment for Palladium Industries, Inc., finding that under its bylaws, Palladium did not owe advancement to David F. Miller III, a former director and the longtime CEO of Palladium, because Palladium’s board of directors formally denied the request as permitted under Palladium’s advancement bylaw.

Palladium’s bylaws included two relevant passages. The first provision stated that defense expenses “shall be paid … in advance of … final disposition.” But the second provision stated that advancement will be paid “unless otherwise determined by the board of directors in the specific case ….” In accordance with this latter provision, the board rejected Miller’s request for advancement.

After applying basic principles of contractual interpretation to Palladian’s bylaws —including the principle that each portion of a document must be given its meaning—the court held that the bylaws permitted the board to reject the request, finding that “Palladium must advance legal fees and expenses if the board does not adopt a contrary directive. This is the only fair reading of the pertinent provision (Art. X) of Palladium’s bylaws.”

The court strongly implied, in dicta, that if a board of directors fails to promptly reject a request for advancement, it will lose its ability to deny the request, even if the corporation’s bylaws impose no temporal limitation on the board’s power to deny an advancement request. The court stated: “Failure of the board to act in a specified time after receipt of a request for advancement will leave the request as a mandatory one. Here, the board acted in a timely fashion—within roughly 30 days from the date of Miller’s demand.” The court seems to have implied a 30-day limit on the board’s power to deny the demand from other portions of the advancement provisions of the bylaws. The section addressing payment of the demand states that it will be made promptly, in any event within 30 days. But the section discussing the board’s power to deny the demand does not impose any such limit. Presumably, the court read the 30-day limit into the other provision.

The court clarified the kind of language that can confer discretion on a board to deny advancement by distinguishing this case from one in which the Delaware Court of Chancery granted advancement despite an attempt by the entity to refuse it, under different contractual terms. In Stockman v. Heartland Industrial Partners, L.P., a partnership agreement contained an advancement provision saying that advancement “shall be paid,” and contained another provision saying, “[n]o advances shall be made by the Partnership under this [provision] without the prior written approval of the General Partner.” The Stockman court ordered the partnership to pay advancement, holding that if the general partner had unbridled discretion over when to grant written approval, that interpretation would gut the meaning of the previous language that required advancement. The Stockman court read the provision granting discretion to endow the general partner with discretion to determine whether the applicant complied with proper forms for requesting advancement.

Contrasting Palladium’s bylaws with those at issue in Stockman, the court emphasized that, “[t]here is no way to give separate and independent meaning to [Palladium’s] ‘unless’ clause except as Palladium has interpreted it.” Also, the section of Palladium’s bylaws that gave the board power to deny an advancement request included an express statement that the section of that bylaw imposing supposedly mandatory advancement was subject to the provision allowing for board denial of advancement.

This case therefore shows the type of provision that can grant a board of directors authority to deny an advancement request in the face of another bylaw that, read on its own, would seem to impose mandatory advancement. Specifically, bylaws that expressly empower a board of directors to deny an advancement request will be enforced as written; bylaws that merely imply that power will not suffice to trump an otherwise plain advancement requirement.

Partner

John Reed

John Reed is a partner the Delaware office of DLA Piper, where he concentrates his practice on corporate litigation and counseling. He can be contacted...